Applying Behavioral Analytics to Fund Managers

Most financial advisors and individual investors judge the worth of investment vehicles solely by their performance, but there's more to the story.

By Savita Iyer-Ahrestani|April 30, 2014 at 01:21 PM

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Most financial advisors and individual investors judge the worth of investment vehicles solely by their performance. There’s not much else to go on, after all, said Clare Flynn Levy, founder and CEO of London-based Essentia Analytics, a software company specializing in behavioral finance.

However, few realize that those performance figures—the outcome of investment decisions taken by portfolio managers—are also a measure of their skills. The better a skill set a portfolio manager has, Flynn Levy said, the better he or she will able to do what they need to do, and this will in turn have a positive impact on their particular fund’s performance.

Few, however, are aware of the importance of skill, and that includes many fund managers themselves.

“At the end of the day, when you’re judged solely on performance, it’s very difficult to maximize your skills,” she said. “And since fund managers are constantly being inundated with new information, they don’t have enough time to digest it all and much less time to look backwards, measure their success and learn from their failings. If you believe, as I do, that there is any skill in fund management, then it’s extremely important to measure that and to be able to maximize it.”

Flynn-Levy, who formerly managed institutional money for a number of large firms including Deutsche Asset Management, set up Essentia Analytics to provide fund managers with a toolbox that does just that. The company’s proprietary cloud-based software seeks to empower portfolio managers—who, she said, are “selling skills but getting paid for performance”—by measuring how, why and when they do what they do. The decision support software enables fund managers to capture richer data about their own behavior and how it affects the decisions they make. It measures every aspect of their investment process, tracks their productivity, their time management and their decision-making processes, with the goal of providing a fund manager with an overall, holistic picture of himself or herself.

The software is built on a simple data in/data out principle. It collects all manner of information about an investment manager: their investment decisions and the context in which these are made, Flynn-Levy said. It uses a range of data, from trades a manager made and particular market contexts in which he or she made them, to the physical contexts in which a particular manager took investment decisions, and the state they were in when they made the decisions, including their energy, emotional and even their hunger levels.

The model’s results can often come as a surprise to managers and reveal positive as well as negative aspects of their behavior and the ways in which these impact their skills and, by extension, their fund’s performance.

“Someone may find they’re good at something they didn’t think they were actually good at, or they may realize they’ve been wasting time and energy on something that ultimately isn’t that important,” Flynn-Levy said. “Through studying their own behavioral patterns, a manager may even learn that they can be much more responsible and productive if they spend more time with their family, for example.”

Flynn-Levy believes this level of detailed behavioral study is extremely important for the asset management business. Fund managers should behave like athletes, she said, and should be performing at the best of their ability, so they must measure their process in order to bring about increased self-awareness and effectuate the necessary behavioral changes to hone their skill set and, eventually, ensure better performance of the products that they manage.

Ultimately, though, the full potential of this exercise can only occur if financial advisors and investors also start to place greater emphasis on portfolio managers’ skill sets when assessing investment products. Financial advisors must stop chasing performance, Flynn-Levy said, because at the end of the day, “people are in for the long-term and they need to pick a manager with the best skill set and who can make the best decisions at every bend in the road. That doesn’t necessarily mean that they will have the best short-term performance.”

Essentia Analytics has brought “common sense” into a tool that is practical for investors to use and will be practical for advisors to interpret, Flynn-Levy said. She launched the firm about a year ago and in that time, has rolled out the software to hedge fund clients and to a growing number of traditional active managers both in the U.K. and in the United States.

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